Why Opportunity Zones may be interesting for investors tackling upward mobility challenges

The U.S. government designed Opportunity Zones as part of the 2017 Tax Cuts and Jobs Act, in order to spur investment in distressed U.S. communities. Governments of each state, the District of Columbia, and five U.S. territories nominated specific neighborhoods as Opportunity Zones. Up to 25 percent of the low-income census tracts in each state could be designated as Opportunity Zones. The IRS has specific regulations around Opportunity Zones.

Opportunity Zones retain their designation for 10 years. Investors may defer tax on almost any capital gain up to Dec. 31, 2026 by making an appropriate investment in a zone, making an election after December 21, 2017, and meeting other requirements.

The proposed regulations state that almost all capital gains qualify for deferral. In the case of a capital gain experienced by a partnership, the rules allow either a partnership or its partners to elect deferral. Similar rules apply to other pass-through entities, such as S corporations and their shareholders as well as estates, trusts, and their beneficiaries.

To qualify for deferral, the amount of a capital gain to be deferred must be invested in a Qualified Opportunity Fund (QOF), which must be an entity treated as a partnership or corporation for Federal tax purposes and organized in any of the 50 states, D.C., or five U.S. territories.

Additionally, the QOF must hold at least 90 percent of its assets in qualified Opportunity Zone property (investment standard). Investors who hold their QOF investment for at least 10 years may qualify to increase their basis to the fair market value of the investment on the date it is sold. [1]

The Treasury and the IRS issued an additional piece of guidance to aid taxpayers in participating in the qualified Opportunity Zone incentive. Rev. Rul. 2018-29 provides guidance for taxpayers on the “original use” requirement for land purchased after 2017 in qualified opportunity zones. They also released Form 8996, which investment vehicles can use to self-certify as QOFs.       

From a community development point of view, Opportunity Zones might not achieve their objectives. The program’s designers claim this will reduce poverty, increase employment, and spur growth. However, research conducted shows this approach has mixed results on promised community development results.  These policies may result mostly in tax giveaways for investment that would have occurred anyway. 

This approach is not new. In the 1980s, Margaret Thatcher’s government tested the idea, creating 11 U.K. “enterprise zones” that offered investors a range of tax breaks and regulatory relief. The most famous of these locations was in London’s dilapidated docks — including Canary Wharf — which underwent a transformation and is now home to many of the country’s major financial institutions.  This experiment may have worked.

The enterprise zone idea came to the U.S. and attracted the interest of U.S. conservative politicians and thinkers such as Brookings Institution and Ronald Regan. More than 40 U.S. states created these zones, which offered a range of incentives, such as tax relief and job training.  The Clinton administration created a related program in 1994 that set up “empowerment zones.” Both programs have since expired.

Scholars found the programs did not work as intended. Alan Peters and Peter Fisher studied 75 enterprise zones in 13 states and found that the tax incentives had “little or no positive impact” on economic growth. Other research shows similar results in Philadelphia.

Opportunity zone advocates have pointed to states like New Jersey and Indiana as examples of success. However, one study suggested that increased economic activity in zones in New Jersey came at the expense of non-zone areas nearby.

In the U.K., supporters of the enterprise zone program highlight the London Docklands, which went from a derelict port to a thriving financial services hub. Yet government studies showed that relatively few jobs were created and that each one cost $35,000 to $45,000 in spending and lost revenue. And, my own research shows that despite these gains the area is still home to some of the most “income deprived households” in the U.K.

The government’s recent effort to revive the program created 29,000 jobs as of 2017, just half the number it promised, at a cost of about $3 billion – about $103,448 per job.

These policies may result in investment tax giveaways that would have occurred anyway.  Also, gentrification displacement may occur. For example, in Louisville, Kentucky, the central business district and the fast-gentrifying tracts of Nulu, Butchertown, and Portland were deemed opportunity zones despite having already seen major capital investment in recent years whereas 7 of the 18 poorest tracts were not.

New York has places like Sunset Park, Brooklyn, that have been targeted despite having already attracted substantial private investment. The New York Times even identified Sunset Park as one of the city’s “hot new neighborhoods.”

Despite this performance of the tax incentive approach in terms of job creation and poverty reduction, the idea continues to attract support on both sides of the Atlantic and across political parties.

[1] The proposed regulations also provide that if at least 70 percent of the tangible business property owned or leased by a trade or business is qualified opportunity zone business property, the requirement that “substantially all” of such tangible business property is qualified opportunity zone business property can be satisfied if other requirements are met. If the tangible property is a building, the proposed regulations provide that “substantial improvement” is measured based on the building’s basis (not on the land). l


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